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Chapter 4 1.

Our desires for goods and services originate in the structure of personality and

social dynamics and are not explained by economic theory. Economic theory focuses ondemand that is, our ability and willingness to buy specific quantities of a good or service at various prices.



Utility refers to the satisfaction we get from consumer goods and services. Total

utility refers to the amount of satisfaction associated with all consumption of a product.Marginal utility refers to the satisfaction obtained from the last unit of a product.


The law of diminishing marginal utility says that the more of a product we

consume, the smaller the increments of pleasure we get from each additional unit. This is the foundation for the law of demand.


The price elasticity of demand (E) is a numerical measure of consumer response to

a change in price (ceteris paribus). It equals the percentage change in quantity demanded divided by the percentage change in price.


If demand is elastic (E > 1), a small change in price induces a large change in

quantity demanded. "Elastic" demand indicates that consumer behavior is very responsive to price changes.

E > 1


If demand is elastic, a price increase will reduce total revenue. Price and total

revenue move in the same direction only if demand is inelastic.


The shape and position of any particular demand curve depend on a consumer's

income, tastes, expectations, and the price and availability of other goods. Should any of these things change, the assumption of ceteris paribus will no longer hold, and the demand curve will shift.


Advertising seeks to change consumer tastes and thus the willingness to buy. If

tastes do change, the demand curve will shift.

Chapter 5 1. Supply decisions are constrained by the capacity to produce and the costs of using

that capacity.


In the short run, some inputs (e.g., land and capital) are fixed in quantity.

Increases in (short-run) output result from more use of variable inputs (e.g., labor).


A production function indicates how much output can be produced from available

facilities using different amounts of variable inputs. Every point on the production function represents efficient production. Capacity output refers to the maximum quantity that can be produced from a given facility.


Output tends to increase at a diminishing rate when more labor is employed in a

given facility. Additional workers crowd existing facilities, leaving each worker with less space and machinery to work with.


The costs of production include both fixed and variable costs. Fixed costs (e.g.,

space and equipment leases) are incurred even if no output is produced. Variable costs (e.g., labor and material) are incurred when plant and equipment are put to use.


Average cost is total cost divided by the quantity produced. The ATC curve is

typically U-shaped.


ATC U Marginal cost is the increase in total cost that results when one more unit of

output is produced. Marginal costs increase because of diminishing returns in production.


The production decision is the short-run choice of how much output to produce

with existing facilities. A producer will be willing to supply output only if price at least covers marginal cost.


The long run is characterized by an absence of fixed costs. The investment

decision entails the choice of whether to acquire fixed costs, that is, whether to build, buy, or lease plant and equipment.


The economic costs of production include the value of all resources used.

Accounting costs typically include only those dollar costs actually paid (explicit costs).


Historically, advances in technology and the quality of our inputs have been the

major source of productivity growth. These advances have shifted production functions up and pushed cost curves down.